Andrew Sheets: The Uncertainty of the Fed’s New Certainty

Why two D.C. policy items—the bipartisan infrastructure framework and debt ceiling deliberations—could add one more complication for equities markets.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between US public policy and financial markets. It's Thursday, September 23rd, at 10:30 a.m. in New York. Markets this week have had a lot to focus on - from the Fed's policy decisions to fresh concerns about global growth. But expect that focus to shift next week, or possibly sooner, to events in Washington, D.C. In particular, watch out for two events that could catalyze some market volatility. First, keep an eye on the planned vote on the bipartisan infrastructure framework, or BIF for short. This vote, which could come as soon as Monday, is a key test for whether or not the Democrats will be able to 'go big' on fiscal policy. That's because the BIF - which would add about $550B of new spending over 10 years to the budget - was supposed to be paired with a bigger, budget reconciliation bill that could reach as high as $3.5T over 10 years. The linking of the two was meant to align the interests of moderate and progressive Democrats in Congress. But that reconciliation bill isn't ready yet for a vote alongside the BIF. So, if the smaller bill gets approved, the moderates will have gotten most of what they want and could be more demanding on the bigger bill, either stalling it or shrinking its size. At the moment, it's far from clear that the BIF can get enough votes to pass on its own, meaning the 'all or nothing' dynamic on fiscal policy remains intact. But if the BIF succeeds, that would suggest a smaller fiscal package, smaller deficit impact, and a key challenge to our view that bond yields will rise meaningfully into year end. We'd also keep a close eye on the deliberations around raising the debt ceiling and avoiding a government shutdown. While the 'x' date - the day by which the debt ceiling needs to be raised or suspended in order to avoid a payment default on Treasuries - is likely the more impactful deadline - which our economists expect will be late October, early November - markets may be more focused on September 30th, the date by which Congress must authorize a continuing resolution for new spending, or else the government shuts down. While we ultimately expect these issues to be resolved in a manner that doesn't materially impact the US growth outlook, the path to resolution on these issues likely requires escalated uncertainty in the near term. Since Democrats have paired the continuing resolution with a debt ceiling hike, which Republicans flatly oppose on the idea that Democrats should go it alone using reconciliation, there's no clear path forward at the moment. For example, the House just passed a continuing resolution, which the Senate is unlikely to be able to carry forward given insufficient Republican support. So, headlines around a government shutdown should pick up, and with it the takes that the situation increases the risk that the debt ceiling can't be raised in a timely manner. Taken together, these two concerns could weigh on the equity market, where our colleagues in cross-asset strategy have suggested performance could be sluggish in the near term as investors grapple with the transition from early to mid economic cycle dynamics. The shift from clear D.C. stimulus support to D.C. uncertainty could be one part of that shift. Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

23 Sep 20213min

On this special episode, we address key questions around struggles in China's property sector, as well as any potential spillover into the broader economy.----- Transcript -----Chetan Ahya Welcome to Thoughts on the Market, I'm Chetan Ahya, Chief Asia Economist for Morgan Stanley,Robin Xing and I'm Robin Zing Morgan Stanley's Chief China Economist.Chetan Ahya And on this special edition of the podcast we'll be diving into the path forward for China's economy amid challenges in the property sector. It's Wednesday, September 22nd, at 7:30 a.m. in Hong Kong.Chetan Ahya So, Robin, as many listeners likely read earlier this week, China's property market is the subject of a lot of market and media focus right now. And near-term funding pressures for some of China's property developers have led to volatility as markets weigh concerns on any ripple effect into China's economy or even the global economy. To put funding pressures in context, in dollar terms, cumulative default in China's high-yield property names this year are already higher than that combined between 2009 and 2020. Robin, I want to get into your base case for China's economy as policymakers manage the property sector outcome. But to understand the backdrop for listeners, maybe it's worthwhile to take a step back to understand China's regulatory reset and the impact it's had on the housing market.Robin Xing So what we call China's regulatory reset is China's ongoing shift in governance priorities, which policymakers drafted last year. And it covers a number of areas, including technology, education, carbon emission, but also property developers in an effort to address the financial stability risks. So the property related financing has actually been tightening since summer 2020. You know, first with new financing rules for real estate companies--what's called the 'three red lines'--which put a leverage cap on developers, then a cap on property, long exposure for banks, and lately, very strict mortgage approval for homebuyers. In this environment, highly leveraged developers are more prone to refinancing risks. And now the question is, will there be more credit events to come? Going forward, tighter financing conditions may stay for developers, which could increase the risk of credit events.Robin Xing So, Chetan, you have been a close watcher for China's debt and the deleveraging dynamics since 2015. First, with its industrial sectors, then it's local government. Then we fast forward to today's housing market. Now, just to gauge how much deleveraging developers still have to undergo, how are we tracking on the three red lines as laid out by regulators? As I recall, developers are required to attain the 'green category,' meeting all three requirements by end of the first half 2023.Chetan Ahya Yeah, thanks, Robin. So, look, I think, first of all, just to appreciate the way China manages its debt challenges is it ensures that the process is taken up in an organized manner and that there are no uncontrolled defaults, which can have ramifications on the financial system as well as overall financial conditions. And property sector is no different. And on that front, our property analyst has been highlighting that out of 26 developers that we cover, only one developer still fails to meet all the three red lines and nine developers have already passed two of those red lines. The remaining 16 developers have already met all the three requirements, and most developers do target to attain green category by the end of next year. Currently, the total debt exposure of the property developers in China is around 18.4trn RMB, which is similar to the annual contract sales or annual sales of these companies, so the deleveraging pressure when you look at it in the context of the level of debt relative to sales, it does seem to be manageable for usChetan Ahya Having said that, Robin, and when you think about the importance of the property sector to the economy, it's quite a significant sector. Property and property related sectors account for 15% of GDP. So, if there is a problem and a developer faces a challenge in meeting its debt obligations, do you think that China can manage the ramifications?Robin Xing Yes, we do think regulators already have a playbook based on past default cases, which included the property developers. That said, the timing of deployment is what may matter most. Potentially Beijing's first goal would be to maintain normal operations of construction projects so default happens at the holding company level and not at the project level, which could reduce spill over to the physical property market. The second goal would be to go for voluntary debt restructuring and avoid a liquidation scenario which could substantially increase the recovery rate, though both of these actions would require coordination across authorities, creditors, and the company in this scenario. We expect the property sales and the investment in China to slow and the new starts would remain weak for the remainder of the year. However, it would not be a very fast and sharp deterioration because current inventory levels for the housing market are low, with around eight months for the major tier-one/tier-two cities. So, it's much lower than previous downturns. So, the overhang on housing new starts should be much smaller. All in all, in this swift intervention and policy easing scenario, we see China's GDP to rebound modestly from the 4.7% in the third quarter in two-year CAGR terms to slightly above 5% in the fourth quarter.Chetan Ahya So, Robin, when you think of the developments in the property market right now, in the context of the fact that the government has also been taking additional regulatory measures which have been weighing on the private business sentiment, do you think that the government can take up easing measures to ensure that this does not have a meaningful impact on the growth outlook?Robin Xing Yes, your concerns are very legitimate. Given the importance of the property sector to China's economy, Beijing may decide to take action sooner rather than later in order to support the economy. In our base case, we are near an inflection point of policy easing. That would be led by faster fiscal spending to support infrastructure investment from September to December, complemented by another 50 basis point reserve requirement ratio cut by the People's Bank of China probably in mid to late October. We also see some easing in mortgage quotas in the fourth quarter. This altogether should drive a modest rebound in broad credit growth in the fourth quarter, marking the end of a 10-month credit growth downturn. What's more, this momentum can be amplified in early next year when the fiscal spending and the credit quota could be front loaded.Chetan Ahya So, Robin, if I were to summarize, essentially what we are talking about is two sets of policy actions to be taken up by the government. First, to ensure that the debt restructuring is taken up in an organized and timely manner. And second is that to the extent to which there will be some negative impact on business sentiment, we're expecting the government to implement policy easing measures.Chetan Ahya However, if the government were to delay these supportive measures, what will be the implications on your growth forecast?Robin Xing That's certainly a scenario we hope to avoid. So basically, should policy makers fail to take actions in time to manage this restructuring and contain its spillover effect, we could see a rise in liquidity pressures on many more developers as banks cut credit lines and home buyer sentiment cools down. In this case, the fourth quarter growth could fall below 4%, far lower than the annual growth target, which was 6% for this year and probably around 5.5% for next year. In short, such delayed action, more spillover scenario would likely warrant a much bigger stimulus in earlier 2022 to meet the growth target to stabilize the job market.Chetan Ahya Robin, thank you for taking the time.Robin Xing It's been great speaking with you.Chetan Ahya And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or a colleague today.

22 Sep 20218min

This Climate Week, we preview environmental policy proposals within the $3.5 Trillion Budget Reconciliation Bill. What will it mean for investors and the response to climate change?----- Transcript -----Jessica Alsford Welcome to Thoughts on the Market. I'm Jessica Alsford, global head of Sustainability Research team at Morgan Stanley.Stephen Byrd And I'm Stephen Byrd, head of Morgan Stanley's North American Research for the Power & Utilities and Clean Energy Industries.Jessica Alsford And on this special Climate Week episode, we'll be talking about some landmark climate and environmental policy proposals in the U.S. and the future of energy. It's Tuesday, September the 21st, at 2:00 p.m. in London.Stephen Byrd And 9:00 a.m. in New York.Jessica Alsford So, Stephen, earlier this month, the U.S. House of Representatives released a draft of some climate and environmental policies as part of its $3.5T budget reconciliation package. I want to dig into your takeaways, but first of all, maybe you could walk us through some of the headline proposals.Stephen Byrd Absolutely, Jessica. This is one of the most exciting pieces of proposed legislation we've seen in the United States, at least with respect to clean energy. And I'll just highlight a handful of very important provisions that are currently in the draft. First, there's a very bold, clean electricity performance program or CEPP that would provide significant incentives for utilities and other loads of green entities to increase their renewables every year. Secondly, there would be a new tax credit for energy storage and biofuels. Third, a major extension of tax credits for wind, solar, fuel cells and carbon capture and payment levels are higher in many cases. Fourth, significant incentives for domestic manufacturing of clean energy equipment. Fifth, what we would call direct pay for tax credits, which basically provides owners with the immediate cash benefit of tax losses. That provides enhanced financing efficiency and better cash flow. Six, a nuclear power production tax credit. Seven, a major clean hydrogen tax credit. And lastly, number eight, significant capital to reduce the risk of wildfires. So very significant. Covers a lot of different areas within the entire clean energy spectrum.Jessica Alsford Absolutely. There's a huge amount in there. I guess maybe just to pick out some key points, are there any particular technologies that you think could really incrementally benefit from this bill versus what the status quo is at the moment?Stephen Byrd Yes, there's definitely a handful of technologies that would benefit in a very significant way. I would say. Probably first on my list is green hydrogen. The proposed payment is three dollars a kilogram - this is the subsidy amount - which is a very large amount of subsidy, in our view, would really kick start growth of green hydrogen across the board in the United States. We did a deep dive into the economics of producing green hydrogen over time, and we do think this amount of subsidy would be a huge boost to the growth of green hydrogen, would defray much of the cost producing green hydrogen. So, any company involved in green hydrogen, I think would see a significant benefit here.Stephen Byrd Another, nuclear power, not new nuclear projects, but existing nuclear assets would receive significant financial support. That is going to serve essentially as a stabilizing force to ensure that we don't see additional shutdowns of nuclear power plants. So that's a big win. I'd say, also, energy storage gets a tax credit for the first time and demand for energy storage is already very high in the United States, but a tax credit that would essentially line up with wind and solar would, we think, provide further incentive for more rapid growth of energy storage. So those are a couple that I would highlight as significant beneficiaries from this proposed legislation.Jessica Alsford Now, this text is the initial draft and say we should probably expect to see changes. What are you hearing in terms of these proposals and how much could actually make it into a final bill?Stephen Byrd This is really interesting. We do think that much of this language will survive. There is one provision, a very important one, that has received pushback. That's the first on the list that I mentioned. This is the Clean Electricity Performance Program or CEPP. Senator Joe Manchin, who's quite important, as well as a few others, have pointed out concerns with the current drafting of the language, a few companies have also expressed concerns. So, we could see changes there, maybe even elimination of that provision. However, many of the other elements of this package do appear to have quite a bit of support. So solar, wind, energy storage, even green hydrogen, we think has a significant amount of support. So, we do think much of this will survive. The one that's been singled out recently is that CEPP.Jessica Alsford Now also on climate, the Biden administration and the EU have actually jointly announced that Global Methane Pledge, which is aiming to reduce methane emissions by at least 30% from 2020 to 2030. Now, what are your thoughts on this? How significant is it for the utility sector?Stephen Byrd Yes, Jessica, I think this cuts both ways in terms of the methane emissions goal. I think on the positive side, I think many investors, especially ESG investors, would like to see significant commitments to reducing methane emissions. And, you know, we can see why certainly methane is so much more harmful from a greenhouse gas perspective relative to CO2. So, I think many investors will applaud this. The big concern will be the cost and the customer bill impact. Right now, given the increase in natural gas prices in the United States and really globally, there is already a concern around the increase in customer bills for those customers who buy natural gas. So, this would increase the cost.Stephen Byrd That said, utilities have a long history of being able to recover these costs. So, on the positive side, this could result in better growth in earnings per share, as well as improved ESG perception and reality in the sense of lower emissions. The key question is how are we going to manage the cost of this? And right now, that's causing quite a bit of investor concern. So, it's a bit of a mixed message. I'd say in the long term, though, a positive from a better growth perspective and lower emissions perspective.Jessica Alsford And finally, from me in this context of the U.S. really increasing its focus on halting climate change, what are the opportunities that you think investors should be looking at?Stephen Byrd So we do see several business models and technologies that should benefit significantly from this policy shift. I would say developers of solar, wind and energy storage will see continued strong support under this legislation. Their incentives would remain in place until the next decade. We would see a lot of benefit for fuel-cell companies and companies involved in the development and transportation of green hydrogen - that would be a major area of support. Existing nuclear power plant owners would receive quite a bit of support as well. So, we do see quite a bit of benefit within this legislation, really providing strong economic support really across the board, but a few areas such as hydrogen that do stick out. But I'd say broadly, if this legislation is passed, clean energy investors would view this as a significant benefit for the entire sector because it is so comprehensive.Stephen Byrd Before we close, Jess, I wanted to ask you about how this might move the needle globally. Europe is clearly out in front on climate legislation, but assuming some or all of these proposals make it into a final bill, how likely is it that we could see similar government action globally?Jessica Alsford It's a timely question, Stephen, really, because we now have COP 26 conference coming up in November. It's being held in Glasgow this year, and we're expecting over 100 world leaders to attend. So, this really should be a catalyst for seeing far more climate focused action globally. Aside from the EU and the US, all eyes are certainly going to be on China. And here, our chief China economist has been writing about a shift in regulatory priorities, so China now are thinking more about a balance between growth and sustainability. And specifically on climate, there are three pillars where we expect to see action from China. First of all, investments in technology. Secondly, carbon pricing and finally on the green financing side.Jessica Alsford Stephen, on Climate Week, thanks for taking the time to talk.Stephen Byrd Any time, Jess. Great speaking with you.Jessica Alsford As a reminder, if you enjoy Thoughts on the Market, please do take a moment to rate and review us on the Apple Podcasts app. It does help more people to find the show.

21 Sep 20218min

Although many commentators point to the S&P 500 near all-time highs as a rationale for higher stock prices, markets may be facing a bumpy road ahead.----- Transcript -----Welcome to Thoughts on the Market. I'm Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the latest trends in the financial marketplace. It's Monday, September 20th, at 12:30pm in New York. So let's get after it. For regular listeners to this podcast our mid-cycle transition narrative is probably getting fairly repetitive. A strong narrative that makes sense is worth riding until the end, and we're not there yet. However, we do think we've entered the final chapter. To recall, the mid-cycle transition began back in March. Initially, it's a more difficult time for the average stock, while the higher quality stocks and indices hold up. Over the last six months that's pretty much exactly what's happened - small caps and lower quality stocks have underperformed the S&P 500 significantly. But now we're entering the final chapter and that's the time when the index starts to underperform the average stock. This happens because that's where investors have been hiding; and at this stage of the transition, investors can no longer hide from the reality of what the mid-cycle transition brings. First, we have a deceleration in economic and earnings momentum. On the economic front, the data has already rolled over pretty hard. While many are blaming the Delta variant for this slowdown in the economy, we think it's more about the payback in demand from a fiscal stimulus and recovery that was unsustainably strong earlier this year. Furthermore, because this recession and recovery were much sharper than normal, we should expect a greater deceleration in growth during the mid-cycle transition phase this time. Finally, due to the nature of this recession being centered around a health crisis, the fiscal support from the government was unusually strong. This led to very high operating leverage and profitability. The normalization means that we could see negative operating leverage for a few quarters as costs are layered back in just as top line growth slows. The bottom line: earnings revisions over the next few quarters will probably look relatively worse than the economic revisions of late. The other headwind for markets that comes at this stage of the mid-cycle transition is the Fed moving away from maximum accommodation. In the 1994 and 2004 versions, the Fed began hiking interest rates. In the 2011 mid-cycle transition, the Fed simply let quantitative easing expire. This time around it's the tapering of asset purchases and we think the Fed will signal that more definitively at this week's meeting. In short, financial conditions should tighten and that means higher interest rates, higher risk premiums or both. Either one means lower equity valuations, which is really the key part of the final chapter of the mid-cycle transition. Once that derating is complete, we can then move forward to the mid-cycle phase, which usually leads to a reacceleration in growth, a broadening out of stock performance and higher equity prices. So how bad will it get? We've been suggesting a 10-15% correction in the S&P 500 is inevitable once we get to the final stage. However, given how long this has taken to play out, the drawdown could end up being closer to 20% if the growth slowdown ends up being worse than normal. In 2011, we had a 19% drawdown, so it's not unprecedented. Therefore, we continue to think investors should hunker down a bit more than normal and skew portfolios toward defensive quality rather than large cap growth quality. Of course, markets can surprise us, which begs the question, what could change our view and allow the S&P 500 to avoid the 10-20% drawdown? First on the list is another fiscal stimulus directed right at the consumer that sustains the well above trend of demand. This could come from either U.S. or China. Second would be a Fed that completely reverses course this week and says they no longer plan to taper asset purchases this year or even next year. Both seem unlikely at this stage, but if markets become somewhat dislocated, we could then see a reaction from policymakers later this fall. Thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.

20 Sep 20213min

We look at how soaring energy prices in Spain, gas prices in the U.S. and aluminum prices globally could all be linked to coal mines in China.----- Transcript -----Andrew Sheets Welcome to Thoughts on the Market, I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley.Martijn Rats And I'm Martijn Rats, Morgan Stanley's global oil strategist and head of the European energy team.Andrew Sheets And on this special episode, we'll be talking about how soaring energy prices in Spain, gas prices in the U.S. and aluminum prices globally could all be linked to coal mines in China. It's Friday, September 17th, at 3 p.m. in London.Andrew Sheets So, Martin, there's a pretty striking story going on globally in commodities that's been hitting close to home here in Europe. I think a good place to start is just to run through how much prices for things like coal, natural gas and aluminum have been rising this year.Martijn Rats Thanks, Andrew. The price rally in many of these commodities has been rather extraordinary. The global consumption of coal peaked in 2013. So eight years ago. And yet we're now looking at thermal coal prices that are close to all time highs. At the start of the year, the price of thermal coal in the seaborne market was in the order of $80/ton. Now we're looking at $180/ton. With that also, the price of aluminum has risen very strongly. At the start of the year, we were around about $2000/ton. At the moment we're knocking on nearly $3000/ton. The price of natural gas both in the seaborne market traded as LNG as liquefied natural gas, but also in Europe, delivered through pipelines at several trading hubs where gas is trading. In Europe, we've seen extraordinary rallies. Typical prices have gone from in the order of $6-7 per MMBTU to $22, $23, $24 per MMBTU. And with that, then also electricity prices have increased very sharply. In Germany, in France, Spain, the U.K., electricity prices have broadly tripled from about sort of 50 euros a megawatt hour to about 150 euros per megawatt hour.Andrew Sheets So one of the reasons I was so keen to talk to you today is that this is a really interesting and interlinked story. What's going on?Martijn Rats I think there is a common set of factors between all of these rallies. In China, electricity demand is up, coming out of covid and also because of hot weather. Normally, China produces its majority of its electricity from coal and from hydropower, i.e. dams and rivers. But because of underinvestment and because of drought, both of these source of electricity production have really struggled this year. That meant that China had to curtail aluminum production, which is particularly electricity intensive to make. China is a big producer of aluminum globally, so that made the global aluminum price spike. At the same time, it meant that China had to look for coal in the seaborne market and also for natural gas, which is another fuel you can use for electricity production. That tightens the global market for coal and for natural gas. And then those prices spiked, particularly in Europe, because normally natural gas that is shipped around the world in LNG tankers, a lot of that ends in Europe. But this year, a far lower share of it ended in Europe. That meant that our inventories of natural gas didn't really build over the summer. We're now going into the winter with unusually low levels of natural gas inventories. Natural gas prices in Europe then spiked. And because that sets the price for electricity, then electricity prices also spiked. It's a global story that is very interconnected across regions and across commodities.Andrew Sheets So, Martin, I know this is hard to comment on, but how do you think this resolves itself? And what do you think are the key factors to watch here going forward as we think about these interconnected commodity markets?Martijn Rats Well, I think these rallies and particularly the sharpened sort of nature of them have really driven home three things. First of all, how interconnected the commodity markets really are. You can get, you know, drought in China and electricity prices go up in Spain. It really is that interconnected. I think the second thing that these rallies drive home is how difficult this is to forecast. As in, even three months ago, six months ago, most market participants would not have expected that in particular, commodities would have rallied so much. As we go into the energy transition, we really should use less coal. And therefore, coal markets were by and large expected to be very well supplied. Natural gas has been quite abundant, really on a global basis ever since the emergence of U.S. shale about a decade ago. And that market, too, was widely expected to remain abundant. So to see these types of price rallies really drives home how difficult it is to forecast these rallies. And frankly, for that reason, we should be open minded about, you know, these deeply held consensual views about how all of this is going to play out. The third thing I think that is worth stressing is that these rallies also show how little margin of safety there is in the broader energy system, and particularly as we do go into the energy transition with seemingly little margin of safety, that creates room for instabilities and spikes in the future as well.Andrew Sheets And, Martin, by the energy transition, we're talking here about this idea that we're really going to be moving away from coal based production, fossil fuels, not just because they're worse for the environment, but they're increasingly less economic relative to many of these renewable technologies that are now out there.Martijn Rats Yeah, that is exactly right. You know, to address climate change and to decarbonize, we need to move to more sustainable low carbon sources of energy. But what is currently going on is that this prospect is leading those that typically invest in the traditional fossil fuels to lower their investment levels already well in advance, whilst actually our consumption patterns are changing quite slowly. So there's a real question whether the prospect of the energy transition is impacting the supply side of energy before it impacts really the demand side of energy. And that's that could then be the source of those price squeezes and instabilities that I just mentioned.Andrew Sheets So, Martin, meanwhile, U.S. gasoline prices have moved up to some of their highest levels since 2014. Is this related to this story and the other commodities or is something else going on here now?Martijn Rats So far, oil is not quite wrapped up in this story quite as much. Oil still has its own standalone dynamic, more or less. And the reason for that is that have loose connections to each other. But oil is truly global. So the United States has reduced its dependance on imported oil very, very significantly over the years, but still, the American oil market is connected to the global oil market. And in the global oil market, we see recovery in demand. The oil market is simply tight and that is driving U.S. gasoline prices. So the dynamic there is different. But where these stories could converge is in terms of the impact of little investment in the future, because clearly part of the story that I just told about natural gas and coal has an element to it of low investment levels that are now showing their consequences and partly responsible for creating these squeezes. In the oil market, we are also now going through a number of years already with low investment levels. Now, there's still some slack in the system, but what is now happening to coal and natural gas could well happen to oil markets in two, three, four years from now when OPEC's spare capacity has been depleted and demand has recovered. So in that sense, U.S. gasoline prices are a different story, but they could become the same story in a few years from now.Martijn Rats So now, Andrew, I look at it from an energy and commodity perspective, but you take a very much a macro view. What do you make of all of this?Andrew Sheets So I think the irony here is, is that both investors or general people who want to reduce carbon based emissions and the energy companies would both prefer higher energy prices, albeit for maybe different reasons. But higher prices are one mechanism to reduce the amount of consumption of these various fossil fuels and commodities. So there is a free market element here. As these prices go up, people will use less electricity, they will use less natural gas, they will try to they will drive less. And that can have some positive environmental impacts. It can also have some negative economic impacts, as if that if that leads to less activity. If that transition has to happen a lot faster or maybe more uncomfortably than expected. I think the second thing is we do have to be on the lookout for this impact on corporate margins. When it comes to commodities and when it comes to the things you were just discussing, if you produce these things, it can be really good. And if you consume them, it can be really challenging. If prices are going up 50-100%, I don't think many people's budgets or earnings numbers account for that type of fluctuation. So, you know, this is something we're going to be watching very closely as we go into third quarter earnings and fourth quarter earnings. And also, I think investors need to be on the lookout for companies that potentially get squeezed if they are not able to pass on price increases onto the next part of the supply chain, onto their customers. And finally, I think this is a really good reminder that there's, I think, a temptation in markets often to really want to think that politics is this great explainer of everything. And I think this is a good reminder of the limitations of that. I mean, I think if you had told an investor at the start of 2020 that you would have Democratic control of the White House, the House of Representatives, the Senate, and then coal prices would go on and more than double. People would have thought that you were crazy. People would have thought that you didn't know what you were talking about. And yet that's happened. And it's happened because there's a drought in China and there's a lack of coal production for many other unrelated reasons. So I think this is just a good example that any time I think we look at markets with upcoming elections, yes, those can matter and they can matter a lot. But often other factors can also come into play. And we need to be mindful and I think kind of humble to that dynamic.Andrew Sheets Martijn, thanks for taking the time to talk.Martijn Rats Great speaking with you, Andrew,Andrew Sheets And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.

17 Sep 202110min

Original Release on August 13th, 2021: Across numerous metrics, the current environment may be an unusually good time to borrow money. What does this mean for equities, credit and government bonds? Chief Cross-Asset Strategist Andrew Sheets explains.----- Transcript -----Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, August 13th, at 4:00 p.m. in London.Obvious things can still matter. Across a number of metrics, this is an unusually good moment to borrow money. And while the idea that interest rates are low is also something we heard a lot about over the prior decade, today we're seeing borrowing cost, ability, and need align in a pretty unique way. For investors, it supports Equities over Credit and caution on government bonds.Let's start with those borrowing costs, which are pretty easy. Corporate bond yields in Europe are at all-time lows, while U.S. companies haven't been able to borrow this cheaply since the early 1950s. Mortgage rates from the U.S. to the Netherlands are at historic lows, and it's a similar story of cheap funding for government bonds.But even more important is the fact that these costs are low relative to growth and inflation. If you borrow to pay for an asset—like equipment or infrastructure or a house—it’s value is probably going to be tied to the price levels and strength of the overall economy. This is why deflation and weak growth can be self-fulfilling: if the value of things falls every year, you should never borrow to buy anything, leading to less lending activity and even more deflationary pressure.That was a fear for a lot of the last decade, when austerity and concerns around secular stagnation ruled the land. And that may have been the fear as recently as 15 months ago with the initial shock of covid. But today it looks different. Expected inflation for the next decade is now above the 20-year average in the US, and Morgan Stanley's global growth forecasts remain optimistic.What about the ability to borrow? After all, low interest rates don't really matter if borrowers can't access or afford them. Here again, we see some encouraging signs. Bond markets are wide open for issuance, with strong year to date trends. Banks are easing lending standards in both the U.S. and Europe. And low yields mean that governments can borrow without risking debt sustainability.So borrowing costs are low even relative to the prior decade, and the ability to borrow has improved. But is there any need? Again, we see encouraging signs and some key differences from recent history.First, our economists see a red-hot capital expenditure cycle with a big uptick in investment spending across the public and private sector. Higher wages are another catalyst here, as they often drive a pretty normal pattern where companies invest more to improve the productivity of the workers they already have.But another big one is the planet. If the weather this summer hasn't convinced you of a shift in the climate, the latest report from the IPCC, the UN's authority on climate change, should. Since 1970, global surface temperatures have risen faster than in any other 50-year period over the last two millennia.Combating climate change is going to require enormous investment - perhaps $10 Trillion by 2030, according to an estimate from the IEA. But there's good news. The economics of these investments have improved dramatically, with the cost of wind and solar power declining 70-90% or more in the last decade. The cost of financing these projects has never been lower or more economical.An attractive borrowing environment is good news for the issuers of debt - companies and governments. It's not so good for those holding these obligations. More supply means, well, more supply, one of several factors we think will push bond yields higher.Thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us a review. We'd love to hear from you.

16 Sep 20213min

Although markets have been preparing for the notion of tax hikes, a flurry of recent legislative activity may suggest where tax policy will eventually land.----- Transcript -----Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, September 15th, at 10:30AM in New York.A flurry of legislative activity over the past week revealed a lot about where tax policy is likely going in the U.S. And while it’s not new news that taxes are likely going up, there are key market observations to be gleaned from the new details that have emerged.First, as we’ve long expected, tax hikes appear to be falling short of the original White House request, reflecting the reality of what every Democrat, including moderates, could support. For example, the House Ways and Means committee’s proposals call for the corporate rate to go to 26.5%, not the 28% asked for. They also call for the highest capital gains rate to go up 5%, not the nearly 20% asked for. These numbers aren’t final, but from here we wouldn’t expect them to move higher. And that’s important for bond investors. In the short term, this means the total amount of revenue these measures can raise probably cannot offset the amount of spending being planned. That means some deficit expansion, and more bond supply could join with other macro factors, like improving growth and a fed on pace to taper, to push bond yields higher over the balance of the year.Second, while the net fiscal package should mean deficit expansion and thus support for growth, the higher taxes could strain equity markets in the very near term. As our colleagues in cross asset strategy have pointed out, the substantial rally in U.S. stocks has left valuations stretched. Further, stocks could be sensitive to a slowing down in the goods economy as the growth cycle matures. Add new taxes to the mix, even the more modest hikes we expect, and it means that stock returns risk lagging for a bit as investors adjust to this more mixed, albeit still positive, macro outlook.A final thought here: while we expect tax changes like these to come through, they are most certainly not a done deal. There are plenty of negotiating hurdles left to clear, and so we wouldn’t expect any finality on the debate until the 4th quarter of this year. We’ll, of course, keep you informed as the situation develops.Thanks for listening. If you enjoy the show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.

15 Sep 20212min

With the summer growth scare in Europe possibly nearing an end—and relatively inexpensive valuations—cyclical stocks in Energy, Banking and Autos may be worth a fresh look.

14 Sep 20213min